SPS COMMERCE INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Forward looking statements regarding us, our business prospects and our results of operations are subject to certain risks and uncertainties posed by many factors and events that could cause our actual business, prospects and results of operations to differ materially from those that may be anticipated by such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. In some cases, you can identify forward-looking statements by the following words: “anticipate,” “assume,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “ongoing,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would,” or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. Similarly, statements that describe our future plans, objectives or goals are also forward-looking. Forward-looking statements may also be made from time to time in oral presentations, including telephone conferences and/or webcasts open to the public. Shareholders, potential investors, and others are cautioned that all forward-looking statements involve risks and uncertainties that could cause results in future periods to differ materially from those anticipated by some of the statements made in this report, including the risks and uncertainties described under the heading “Risk Factors” appearing in our Annual Report on Form 10-K for the year ended December 31, 2022, as may be updated in our subsequent Quarterly Reports on Form 10-Q from time to time. We expressly disclaim any intent or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the SEC that advise interested parties of the risks and factors that may affect our business. Overview SPS Commerce is a leading provider of cloud-based supply chain management services across our global retail network. Our products make it easier for retailers, grocers, distributors, suppliers, and logistics firms to communicate and collaborate by simplifying how they manage and share item, inventory, order and sales data across omnichannel retail channels. We deliver our products using a full-service model, which includes industry-leading technology and a team of experts that optimize, update, and operate the technology on customers' behalf. Our products enable customers to increase supply chain performance, optimize inventory levels and sell-through, reduce operational costs, improve order visibility, and satisfy consumer demands for a seamless omnichannel experience. We plan to continue to grow our business by further penetrating the supply chain management market, increasing revenues from our customers as their businesses grow, expanding our distribution channels, expanding our international presence and, from time to time, developing new products and applications. We also intend to selectively pursue acquisitions that will add customers, allow us to expand into new regions, or allow us to offer new functionalities. Key Financial Terms, Metrics and Non-GAAP Measures We have several key financial terms, metrics, and non-GAAP measures as discussed in our Annual Report on Form 10-K for the year ended December 31, 2022, as filed with the SEC, under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” To supplement our consolidated financial statements, we provide investors with Adjusted EBITDA, Adjusted EBITDA Margin, and non-GAAP income per share, all of which are non-GAAP financial measures. We believe that these non-GAAP financial measures provide useful information to our management, Board of Directors, and investors regarding certain financial and business trends relating to our financial condition and results of operations. Our management uses these non-GAAP financial measures to compare our performance to that of prior periods for trend analyses and planning purposes. Adjusted EBITDA is also used for purposes of determining executive and senior management incentive compensation. We believe these non-GAAP financial measures are useful to an investor as they are widely used in evaluating operating performance. Adjusted EBITDA and Adjusted EBITDA Margin are used to measure operating performance without regard to items such as depreciation and amortization, which can vary depending upon accounting methods and the book value of assets, and to present a meaningful measure of corporate performance exclusive of capital structure and the method by which assets were acquired. These non-GAAP financial measures should not be considered a substitute for, or superior to, financial measures calculated in accordance with GAAP. These non-GAAP financial measures exclude significant expenses and income that are required by GAAP to be recorded in our consolidated financial statements and are subject to inherent limitations. Investors should review the reconciliations of non-GAAP financial measures to the comparable GAAP financial measures that are included in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” SPS COMMERCE, INC. 18 Form 10-Q for the Quarterly Period ended September 30, 2023 Table of Contents Results of Operations Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022 The following table presents our results of operations for the periods indicated: Three Months Ended September 30, 2023 2022 Change ($ in thousands) $ % of revenue (1) $ % of revenue (1) $ % Revenues $ 135,661 100.0 % $ 114,486 100.0 % $ 21,175 18.5 % Cost of revenues 45,521 33.6 38,605 33.7 6,916 17.9 Gross profit 90,140 66.4 75,881 66.3 14,259 18.8 Operating expenses Sales and marketing 30,289 22.3 25,334 22.1 4,955 19.6 Research and development 13,558 10.0 11,135 9.7 2,423 21.8 General and administrative 21,906 16.1 16,724 14.6 5,182 31.0 Amortization of intangible assets 3,788 2.8 2,998 2.6 790 26.4 Total operating expenses 69,541 51.3 56,191 49.1 13,350 23.8 Income from operations 20,599 15.2 19,690 17.2 909 4.6 Other income (expense), net 1,702 1.3 (695) (0.6) 2,397 (344.9) Income before income taxes 22,301 16.4 18,995 16.6 3,306 17.4 Income tax expense 5,459 4.0 3,132 2.7 2,327 74.3 Net income $ 16,842 12.4 % $ 15,863 13.9 % $ 979 6.2 % (1) Amounts in column may not foot due to rounding Revenues - Revenues increased for the 91st consecutive quarter. The increase in revenue resulted from two primary factors: the increase in recurring revenue customers, which is driven primarily by continued business growth and by business acquisitions, and the increase in average recurring revenues per recurring revenue customer, which we also refer to as wallet share. • The number of recurring revenue customers increased 13% to 44,500 at September 30, 2023 from 39,550 at September 30, 2022 primarily due to sales and marketing efforts to acquire new customers and due to recent acquisitions. • Wallet share increased 7% to $11,650 for the three months ended September 30, 2023 from $10,900 for the same period in 2022. This was primarily attributable to increased usage of our products by our recurring revenue customers. Recurring revenues increased 20% to $127.4 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. Recurring revenues accounted for 94% of our total revenues for the three months ended September 30, 2023 compared to 93% for the three months ended September 30, 2022 . We anticipate that the number of recurring revenue customers and wallet share will continue to increase as we execute our growth strategy focused on further penetration of our market. Cost of Revenues - The increase in cost of revenues was primarily due to increased headcount, which resulted in an increase of $5.5 million in personnel-related costs. Sales and Marketing Expenses - The increase in sales and marketing expense was primarily due to increased headcount, which resulted in an increase of $3.2 million in personnel-related costs. Research and Development Expenses - The increase in research and development expense was primarily due to increased headcount, which resulted in an increase of $1.8 million in personnel-related costs. SPS COMMERCE, INC. 19 Form 10-Q for the Quarterly Period ended September 30, 2023 Table of Contents General and Administrative Expenses - The increase in general and administrative expense was primarily related to increased stock-based compensation of $2.1 million. Additionally, the increase was due to supporting continued business growth, including an increase in headcount which resulted in an increase in personnel-related costs of $1.8 million. Finally, there was an increase in credit loss expense of $1.3 million due primarily to overall business growth. Amortization of Intangible Assets - The increase in amortization of intangible assets was driven by acquired intangible assets related to recent business combinations. Other Income (Expense), Net - The increase in other income (expense), net was primarily due to favorable investment returns and foreign currency exchange rate changes. Income Tax Expense - The increase in income tax expense was primarily driven by the increase in pre-tax income, and reduction in the excess tax deductions from the current period equity award settlements as compared to prior year. Excess tax benefits generated upon the settlement or exercise of stock awards are recognized as a reduction to income tax expense and, as a result, we expect that our annual effective income tax rate will fluctuate. Adjusted EBITDA - Adjusted EBITDA consists of net income adjusted for income tax expense, depreciation and amortization expense, stock-based compensation expense, realized gain or loss from foreign currency on cash and investments held, investment income or loss, and other adjustments as necessary for a fair presentation. Other adjustments included the expense impact from acquisition-related employee severance costs. Net income is the comparable GAAP measure of financial performance. The following table provides a reconciliation of net income to Adjusted EBITDA: Three Months Ended September 30, (in thousands) 2023 2022 Net income $ 16,842 $ 15,863 Income tax expense 5,459 3,132 Depreciation and amortization of property and equipment 4,675 4,169 Amortization of intangible assets 3,788 2,998 Stock-based compensation expense 11,436 7,960 Realized (gain) loss from foreign currency on cash and investments held (98) 1,151 Investment income (2,635) (586) Other 1,036 — Adjusted EBITDA $ 40,503 $ 34,687 Adjusted EBITDA Margin - Adjusted EBITDA Margin consists of Adjusted EBITDA divided by revenue. Margin, the comparable GAAP measure of financial performance, consists of net income divided by revenue. The following table provides a comparison of Margin to Adjusted EBITDA Margin: Three Months Ended September 30, (in thousands, except Margin and Adjusted EBITDA Margin) 2023 2022 Revenue $ 135,661 $ 114,486 Net income 16,842 15,863 Margin 12 % 14 % Adjusted EBITDA 40,503 34,687 Adjusted EBITDA Margin 30 % 30 % SPS COMMERCE, INC. 20 Form 10-Q for the Quarterly Period ended September 30, 2023 Table of Contents Non-GAAP Income per Share - Non-GAAP income per share consists of net income adjusted for stock-based compensation expense, amortization expense related to intangible assets, realized gain or loss from foreign currency on cash and investments held, other adjustments as necessary for a fair presentation, including the expense impact from acquisition-related employee severance costs, and the corresponding tax impacts of the adjustments to net income, divided by the weighted average number of shares of common and diluted stock outstanding during each period. Net income per share, the comparable GAAP measure of financial performance, consists of net income divided by the weighted average number of shares of common and diluted stock outstanding during each period. To quantify the tax effects, we recalculated income tax expense excluding the direct book and tax effects of the specific items constituting the non-GAAP adjustments. The difference between this recalculated income tax expense and GAAP income tax expense is presented as the income tax effect of the non-GAAP adjustments. The following table provides a reconciliation of net income per share to non-GAAP income per share: Three Months Ended September 30, (in thousands, except per share amounts) 2023 2022 Net income $ 16,842 $ 15,863 Stock-based compensation expense 11,436 7,960 Amortization of intangible assets 3,788 2,998 Realized (gain) loss from foreign currency on cash and investments held (98) 1,151 Other 1,036 — Income tax effects of adjustments (4,981) (4,866) Non-GAAP income $ 28,023 $ 23,106 Shares used to compute net income and non-GAAP income per share Basic 36,728 36,093 Diluted 37,584 36,915 Net income per share, basic $ 0.46 $ 0.44 Non-GAAP adjustments to net income per share, basic 0.30 0.20 Non-GAAP income per share, basic $ 0.76 $ 0.64 Net income per share, diluted $ 0.45 $ 0.43 Non-GAAP adjustments to net income per share, diluted 0.30 0.20 Non-GAAP income per share, diluted $ 0.75 $ 0.63 SPS COMMERCE, INC. 21 Form 10-Q for the Quarterly Period ended September 30, 2023 Table of Contents Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022 The following table presents our results of operations for the periods indicated: Nine Months Ended September 30, 2023 2022 Change ($ in thousands) $ % of revenue (1) $ % of revenue (1) $ % Revenues $ 391,945 100.0 % $ 328,857 100.0 % $ 63,088 19.2 % Cost of revenues 133,029 33.9 111,524 33.9 21,505 19.3 Gross profit 258,916 66.1 217,333 66.1 41,583 19.1 Operating expenses Sales and marketing 89,722 22.9 74,571 22.7 15,151 20.3 Research and development 39,438 10.1 33,268 10.1 6,170 18.5 General and administrative 64,275 16.4 49,390 15.0 14,885 30.1 Amortization of intangible assets 11,118 2.8 7,936 2.4 3,182 40.1 Total operating expenses 204,553 52.2 165,165 50.2 39,388 23.8 Income from operations 54,363 13.9 52,168 15.9 2,195 4.2 Other income (expense), net 4,859 1.2 (1,610) (0.5) 6,469 (401.8) Income before income taxes 59,222 15.1 50,558 15.4 8,664 17.1 Income tax expense 12,409 3.2 11,339 3.4 1,070 9.4 Net income $ 46,813 11.9 % $ 39,219 11.9 % $ 7,594 19.4 % (1) Amounts in column may not foot due to rounding Revenues - The increase in revenue resulted from two primary factors: the increase in recurring revenue customers, which is driven primarily by continued business growth and by business acquisitions, and the increase in average recurring revenues per recurring revenue customer, which we also refer to as wallet share. • The number of recurring revenue customers increased 13% to 44,500 at September 30, 2023 from 39,550 at September 30, 2022 primarily due to sales and marketing efforts to acquire new customers and due to recent acquisitions . • Wallet share increased 7% to $11,250 for the nine months ended September 30, 2023 from $10,550 for the same period in 2022. The increase was primarily attributable to increased usage of our solutions by our recurring revenue customers. Recurring revenues increased 20% to $366.2 million for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. Recurring revenues from recurring revenue customers accounted for 93% of our total revenues for the nine months ended September 30, 2023 and 2022, respectively. We anticipate that the number of recurring revenue customers and wallet share will continue to increase as we execute our growth strategy focused on further penetrations of our market. Cost of Revenues - The increase in cost of revenues was primarily due to increased headcount, which resulted in increases of $16.3 million in personnel-related costs and $2.0 million of software subscriptions. Additionally, the increase was due to a $1.1 million increase in stock-based compensation. Sales and Marketing Expenses - The increase in sales and marketing expense was primarily due to increased headcount, which resulted in increases of $10.2 million in personnel-related costs and $1.9 million in variable compensation earned by sales personnel and referral partners. Additionally, the increase was due to a $1.5 million increase in stock-based compensation. SPS COMMERCE, INC. 22 Form 10-Q for the Quarterly Period ended September 30, 2023 Table of Contents Research and Development Expenses - The increase in research and development expense was primarily due to increased headcount, which resulted in an increase of $4.1 million in personnel-related costs. Additionally, the increase was due to a $1.1 million increase in stock-based compensation. General and Administrative Expenses - The increase in general and administrative expense was primarily related to increased stock-based compensation of $6.7 million. Additionally, the increase was due to supporting continued business growth, including an increase in headcount which resulted in an increases in personnel-related costs of $4.3 million and software subscriptions of $1.0 million. Finally, there was an increase in credit loss expense of $1.1 million due primarily to overall business growth. Amortization of Intangible Assets - The increase in amortization of intangible assets was driven by acquired intangible assets related to recent business combinations. Other Income (Expense), Net - The increase in other income (expense), net was primarily due to favorable investment returns and foreign currency exchange rate changes. Income Tax Expense - The increase in income tax expense was primarily driven by the increase in pre-tax income, as partially offset by the change in the excess tax deductions due to the current period equity award settlements. Excess tax benefits generated upon the settlement or exercise of stock awards are recognized as a reduction to income tax expense and, as a result, we expect that our annual effective income tax rate will fluctuate. Adjusted EBITDA - Adjusted EBITDA consists of net income adjusted for income tax expense, depreciation and amortization expense, stock-based compensation expense, realized gain or loss from foreign currency on cash and investments held, investment income or loss, and other adjustments as necessary for a fair presentation. Other adjustments included the expense impacts from acquisition-related employee severance costs and disposals of certain capitalized internally developed software. Net income is the comparable GAAP measure of financial performance. The following table provides a reconciliation of net income to Adjusted EBITDA: Nine Months Ended September 30, (in thousands) 2023 2022 Net income $ 46,813 $ 39,219 Income tax expense 12,409 11,339 Depreciation and amortization of property and equipment 13,964 11,983 Amortization of intangible assets 11,118 7,936 Stock-based compensation expense 36,097 25,636 Realized (gain) loss from foreign currency on cash and investments held (525) 2,010 Investment income (5,372) (806) Other 1,170 — Adjusted EBITDA $ 115,674 $ 97,317 Adjusted EBITDA Margin - Adjusted EBITDA Margin consists of Adjusted EBITDA divided by revenue. Margin, the comparable GAAP measure of financial performance, consists of net income divided by revenue. SPS COMMERCE, INC. 23 Form 10-Q for the Quarterly Period ended September 30, 2023 Table of Contents The following table provides a comparison of Margin to Adjusted EBITDA Margin: Nine Months Ended September 30, (in thousands, except Margin and Adjusted EBITDA Margin) 2023 2022 Revenue $ 391,945 $ 328,857 Net income 46,813 39,219 Margin 12 % 12 % Adjusted EBITDA 115,674 97,317 Adjusted EBITDA Margin 30 % 30 % Non-GAAP Income per Share - Non-GAAP income per share consists of net income adjusted for stock-based compensation expense, amortization expense related to intangible assets, realized gain or loss from foreign currency on cash and investments held, other adjustments as necessary for a fair presentation, including the expense impacts from acquisition-related employee severance costs and disposals of certain capitalized internally developed software, and the corresponding tax impacts of the adjustments to net income, divided by the weighted average number of shares of common and diluted stock outstanding during each period. Net income per share, the comparable GAAP measure of financial performance, consists of net income divided by the weighted average number of shares of common and diluted stock outstanding during each period. To quantify the tax effects, we recalculated income tax expense excluding the direct book and tax effects of the specific items constituting the non-GAAP adjustments. The difference between this recalculated income tax expense and GAAP income tax expense is presented as the income tax effect of the non-GAAP adjustments. The following table provides a reconciliation of net income per share to non-GAAP income per share: Nine Months Ended September 30, (in thousands, except per share amounts) 2023 2022 Net income $ 46,813 $ 39,219 Stock-based compensation expense 36,097 25,636 Amortization of intangible assets 11,118 7,936 Realized (gain) loss from foreign currency on cash and investments held (525) 2,010 Other 1,170 — Income tax effects of adjustments (16,089) (11,576) Non-GAAP income $ 78,584 $ 63,225 Shares used to compute net income and non-GAAP income per share Basic 36,584 36,104 Diluted 37,417 36,942 Net income per share, basic $ 1.28 $ 1.09 Non-GAAP adjustments to net income per share, basic 0.86 0.66 Non-GAAP income per share, basic $ 2.14 $ 1.75 Net income per share, diluted $ 1.25 $ 1.06 Non-GAAP adjustments to net income per share, diluted 0.86 0.66 Non-GAAP income per share, diluted $ 2.11 $ 1.72 SPS COMMERCE, INC. 24 Form 10-Q for the Quarterly Period ended September 30, 2023 Table of Contents Critical Accounting Policies and Estimates This discussion of our financial condition and results of operations is based upon our condensed consolidated financial statements, which are prepared in accordance with GAAP and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The preparation of these consolidated financial statements requires us to make estimates, judgments, and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures. On an ongoing basis, we evaluate our estimates, judgments, and assumptions. We base our estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that we believe to be reasonable. Our actual results may differ from these estimates under different assumptions or conditions. A critical accounting policy or estimate is one that is both material to the presentation of our financial statements and requires us to make difficult, subjective, or complex judgments relating to uncertain matters that could have a material effect on our financial condition and results of operations. Accordingly, we believe that our policies for revenue recognition, internally developed software, and business combinations are the most critical to fully understand and evaluate our financial condition and results of operations. During the nine months ended September 30, 2023, there were no changes in our critical accounting policies or estimates. For additional information regarding our critical accounting policies and estimates, see the discussion under "Critical Accounting Policies and Estimates" in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year ended December 31, 2022, as filed with the SEC. Liquidity and Capital Resources As of September 30, 2023 , our principal sources of liquidity were cash and cash equivalents and short-term investments totaling $239.3 million and net accounts receivable of $45.1 million. Our investments are selected in accordance with our investment policy, with a goal of maintaining liquidity and capital preservation. Our cash equivalents and short-term investments are held in highly liquid money market funds, certificates of deposits, and commercial paper. The summary of activity within the condensed consolidated statements of cash flows was as follows: Nine Months Ended September 30, (in thousands) 2023 2022 Net cash provided by operating activities $ 99,512 $ 76,483 Net cash used in investing activities (93,448) (60,593) Net cash provided by (used in) financing activities 10,005 (36,655) Net Cash Flows from Operating Activities The increase in cash provided by operating activities was primarily driven by changes in the amount and timing of settlement of operating assets and liabilities, in addition to increased net income. Net Cash Flows from Investing Activities The increase in cash used in investing activities was primarily due to acquisition activity. Net Cash Flows from Financing Activities The change in cash provided by (used in) financing activities was primarily due to the decrease in cash used for share repurchases. SPS COMMERCE, INC. 25 Form 10-Q for the Quarterly Period ended September 30, 2023 Table of Contents Contractual and Commercial Commitment Summary Our contractual obligations and commercial commitments as o f September 30, 2023 are summarized below: Payments Due by Period (in thousands) Less Than 1 Year 1-3 Years 3-5 Years More Than 5 Years Total Operating lease obligations, including imputed interest $ 4,982 $ 8,782 $ 2,264 $ 79 $ 16,107 Purchase commitments 11,518 17,580 — — 29,098 Total $ 16,500 $ 26,362 $ 2,264 $ 79 $ 45,205 Future Capital Requirements Our future capital requirements may vary significantly from those now planned and will depend on many factors, including: • costs to develop and implement new products and applications, if any; • sales and marketing resources needed to further penetrate our market and gain acceptance of new products and applications that we may develop; • expansion of our operations in the U.S. and internationally; • response of competitors to our products and applications; and • use of capital for acquisitions. Historically, we have experienced increases in our expenditures consistent with the growth in our operations and personnel, and we anticipate that our expenditures will continue to increase as we expand our business. We believe our cash, cash equivalents, investments, and cash flows from our operations will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements, investments in special purpose entities or undisclosed borrowings or debt. Additionally, we are not a party to any derivative contracts or synthetic leases. Foreign Currency Exchange and Inflation Rate Changes For information regarding the effect of foreign currency exchange rate changes, refer to the section entitled “Foreign Currency Exchange Risk,” included in Part I, Item 3, “Quantitative and Qualitative Disclosures About Market Risk” of this Quarterly Report on Form 10-Q. Inflation and changing prices did not have a material effect on our business during the nine months ended September 30, 2023 and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future.